American Law Institute Adopts The Restatement Of The Law, Liability Insurance

Four Potential Landmines For Insurers

While it is not a judicial one, the decision, in May, of the American Law Institute, to adopt its Restatement of the Law, Liability Insurance, certainly qualifies as one of the ten most significant of the year.

The years-long debate, at times contentious, over the substance of the RLLI, was well-publicized. That is now in the rear view mirror. But while one debate over the RLLI has ended, a new one is getting underway -- the role it may play in courts’ decision making. As Alexander Graham Bell said, when one door closes another door opens. Fraulein Maria, in the Sound of Music, made a similar observation.

While nobody knows what the role of the RLLI may be, I’ve given it some thought and have a take on it. In addition, as discussed below, I believe that the possible impact of the RLLI can only be rightly considered on a provision-by-provision and state-by-state basis. Comprising 50 sections and 500 pages, it is not an all or nothing proposition. Based on that, I see four aspects of the RLLI that could have a significant impact on insurers. I address these four potential landmines below.

Possible Role of the Restatement of the Law, Liability Insurance

Any consideration, of the possible role of the RLLI, must start with this fundamental truth – it is not precedential in any court, in any jurisdiction. Second, the Restatement is comprised of 50 sections, addressing a multitude of liability coverage issues. Third, the state of the law on coverage issues can differ dramatically between jurisdictions – both to the extent it has been developed and its treatment of substantive principles. Based on this confluence of factors, the possible impact of the RLLI is likely tied to the state of the law on each provision and in each jurisdiction. In other words, if there is law on a certain issue, in a particular state, it is less likely – and, in some cases, much less likely -- that a court would have any reason to consider the RLLI for guidance. This reduces the possible impact of the RLLI.

Conversely, when a court comes upon a coverage issue of first impression in its state or one in which any homegrown law is not clear-cut, courts frequently turn to out of state decisions and/or secondary sources for guidance. Of course these decisions and sources are not binding, but they are instructive to a court in need of an answer. In the course of doing so, the RLLI may now be included in the list of sources that a court turns to for help in an unchartered territory situation. Knowing that Restatements are developed by learned individuals at the ALI, following a long and painstaking process, it would not be unreasonable that a court would look to what the RLLI has to say about the issue.

Here are some examples of how this has already played out in courts. The RLLI was cited by courts even before it was given final approval.

Lack of Case Law

In Selective Insurance Company of America v. Smiley Body Shop, Inc., 260 F. Supp. 3d 1023 (S.D. Ind. 2017), an Indiana federal court addressed an insurer’s right to reimbursement of defense costs. The court first noted that there was no Indiana authority that had spoken to this issue. So, not surprisingly, the court looked to other decisions for guidance (3rd Circuit, 10th Circuit and Illinois Supreme Court) and noted that these courts found that an insurer did not have a right to recoup defense costs. Then the court turned to the RLLI (even as a draft) for further guidance, which it noted does not permit reimbursement of defense costs. In the end, the court was not required to answer the reimbursement question. However, if it were, the court, using the RLLI for support, was seemingly poised to conclude that the insurer did not have such a right.

In Gilbane v. Liberty Insurance Underwriters, No. 16 CH 15163 (Cir. Ct. Cook Cty. Nov. 2, 2018), the court was again called upon to decide if an insurer was entitled to reimbursement – this time of an indemnity payment. The court was tasked to reach its decision under Rhode Island law, which was acknowledged to provide little guidance on the issue. [So little that the court did not say what this guidance was.] The court acknowledged, rightly so, that “[s]tates are split on whether insurers have the right to seek reimbursement from the insured for defense costs and indemnity or settlement payments.” In disallowing reimbursement, the court included in its analysis the fact that the RLLI disallows reimbursement.

Case Law Exists

In Catlin Specialty Ins. Co. v. J.J. White, Inc., No. 14-1255 (E.D. Pa. Feb. 27, 2018), the court addressed a coverage issue that was the subject of precedent in the relevant jurisdiction (New York). The court concluded that the insurer breached its duty to defend. However, despite an argument from the policyholder, the court was not willing to hold that the insurer waived the right to argue that it may not owe coverage for indemnity. In other words, the court did not adopt the so-called “waiver rule” – which was supported by an early draft of the RLLI. And, as the court saw it, why would it? After all, as the court noted, the waiver rule was rejected by the New York Court of Appeals in K2 v. American Guarantee (N.Y. 2014).

While the court in J.J. White declined to adopt the RLLI, over high court precedent, the court in Catlin Specialty Ins. Co. v. CBL & Assocs. Props., 2018 Del. Super. LEXIS 342 (Del. Super. Ct. Aug. 9, 2018) needed much less in the way of existing case law to be persuaded to decline the follow the RLLI. The court permitted an insurer to seek reimbursement of defense costs. In rejecting the policyholder’s RLLI-based argument, that the court should preclude such reimbursement, the court was persuaded by an eleven year old federal district court decision, from the relevant jurisdiction, that permitted reimbursement.

Four Potential Insurer Landmines in the Restatement of the Law, Liability Insurance

As noted above, the possible impact of the RLLI can only be rightly considered on a provision-by-provision and state-by-state basis. Moreover, I believe that the RLLI is likely to have the most influence when a court comes upon a coverage issue of first impression in its state or one in which its law is not clear-cut. Based on this, I see four aspects of the RLLI that could have significant impacts for insurers. These all involve scenarios where there is not an abundance of case law. Hence, a court considering applying the RLLI would have less competition for doing so.

Updating Reservation of Rights

Not surprisingly, the RLLI (§ 15) affords insurers the right to undertake a defense under a reservation of rights. This Restatement section then goes on to state that, “if an insurer already defending a legal action learns of information, which it did not have constructive notice of under subsection (1) [for the original ROR], that provides a ground for contesting coverage for that action, the insurer must give notice of that ground to the insured within a reasonable time to reserve the right to contest coverage for the action on that ground.”

So the RLLI states that an insurer, in receipt of information that gives rise to a new coverage defense, must send a supplemental reservation of rights letter. A comment to § 15 then states: “An insurer should know within a reasonable time any allegation contained in any pleading and in any other filing or transcript that a reasonable insurer managing the defense of a case would have reviewed.”

Translation – the RLLI, based on a comment, purports to impose upon the insurers the task of reviewing all pleadings and deposition transcripts – which could be many and voluminous -- to identify new coverage defenses, and issue an updated reservation of rights. Just as with the fairly inform requirement, discussed next, and the adequacy of reservation of rights letters could become a more frequently disputed issue.

Reservation of Rights: The Fairly Inform Standard

Much has been discussed in the past few years about the obligation of insurers to issue reservation of rights letters that do more than simply set out some facts and quote policy language and then declare, viola, that the insurer’s rights have been reserved. Some courts have penalized insurers for issuing ROR letters that did not fairly inform the insured, i.e., adequately explain, with specific facts tied to the potentially relevant policy provisions, why coverage might not be owed.

The RLLI’s § 15 adopts this fairly inform standard: “Notice to the insured of a ground for contesting coverage must include a written explanation of the ground, including the specific insurance policy terms and facts upon which the potential ground for contesting coverage is based, in language that is understandable by a reasonable person in the position of the insured.”

With only a few states having specifically discussed the “fairly inform” standard for ROR letters, the RLLI gives the rule a wider base of support.

Insurer Receiving Information From Defense Counsel

Section 10 of the RLLI gives insurers wide latitude in controlling a defense that it is providing. However, § 10 then goes on to state that the insurer’s “right to receive from defense counsel all information relevant to the defense or settlement of the action, [is] subject to the exception for confidential information stated in § 11(2).” Turning to § 11(2), it provides that “[a]n insurer does not have the right to receive any information of the insured that is protected by attorney—client privilege, work-product immunity, or a defense lawyer’s duty of confidentiality under rules of professional conduct, if that information could be used to benefit the insurer at the expense of the insured.”

Reading these two provisions together, defense counsel cannot provide information to its client’s insurer that “could be used to benefit the insurer at the expense of the insured.” Of course, defense counsel almost always maintains that it has no involvement in coverage issues. That’s between his or her client and its insurer. But, under these provisions, defense counsel must be quite familiar with the coverage issues. Otherwise, how would defense counsel know if information provided to the insurer “could be used to benefit the insurer at the expense of the insured?” Prudent defense would presumably err on the side of caution and provide very little information to the insurer -- perhaps only discovery responses and deposition transcripts. This could lead to insurers being called upon to make settlement or trial decisions, without the benefit of a full analysis from defense counsel, who was fearful of providing information that could be used to benefit the insurer at the expense of the insured.

Excess Liability For Non-Bad Faith Breach Of The Duty To Defend

Section 48 of the RLLI sets forth damages available for a breach of a liability policy – even if the breach was not in bad faith. The list includes reasonable defense costs, any indemnity owed, damages for failure to settle and “[a]ny other loss, including incidental or consequential loss, caused by the breach, provided that the loss was foreseeable by the insurer at the time of contracting as a probable result of a breach, which sums are not subject to any limit of the policy.”

Thus, under § 48, an insurer that breaches the duty to defend, and not in bad faith, could potentially be liable for a judgment in excess of its limits. Coincidentally, as 2018 was coming to a close, the Supreme Court of Nevada cited to § 48 in reaching just such a decision. See Century Surety Company v. Andrew, 2018 Nev. LEXIS 112 (Nev. Dec. 13, 2018) further down the list of the year’s ten most significant liability coverage decisions.